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Monday, December 06, 2004

The high price of subsidies--From the Buffalo News

What is wrong with government subsidies? A great deal!

Deciding what projects to invest in is hard work. And often times we do make mistakes, but time and time again the evidence shows that free markets make the best decisions. (In class terminology, markets make the best allocation decisions and funnel the money to its highest valued use.)

However, all too often politicians can not help but to play the game as well--but not with their money, but with taxpayers money.

This is a classic agency cost problem whereby the politician gets benefits while each tax payer pays a small portion. This is problematic because it often leads to investments in projects that yield no reasonable chance of being profitable. To make matters worse, there is often no easy way to measure success (unlike the stock market), and the project often being popular in some sense or to some people, or for a short period of time.

The result? More money is spent on the project than should be—in class terms we invest in negative NPV projects.

The SportEconomist has long railed against subsidization. For instance he posted a great article on the lack of success Cleveland has had after they funded their Gund Arena. (But even in this instance, note the difficulty in measuring success.)

I would like to extend the disagreement with subsidization beyond just Sports complexes and teams. It is unclear why governments should be allowed to pick favorites in any business.

Why? Because by picking Bass, the government is paying for a new project. Who is paying for it? Among others are other retail stores that will now face increased competition.

Why play favorites? What about all of the already struggling businesses in Buffalo and elsewhere in New York State that did NOT get tax breaks? A better idea is to lower taxes to all so that businesses (and not just Bass) would willingly relocate to New York State.

But of course the temptation is great. From today's Buffalo News - The high price of subsidies: The "'silver bullet' projects sometimes are off target. Just as Buffalo officials are celebrating the Bass Pro announcement, Rochester leaders are figuring how to bounce back from a celebrated public-private partnership that fizzled in their city. Rochester, New York State and the federal government contributed an estimated $35 million toward a high-speed ferry project, for a terminal and for the vessel. The goal of that project was similar to Buffalo's Bass Pro deal - to spur development of a city's waterfront. But the debt-laden private operator of the Rochester-to-Toronto ferry halted the twice-a-day round-trip crossings in September, just three months after launching the service. Now, Rochester Mayor William Johnson Jr. wants the city to buy the ferry for an estimated $40 million, using the proceeds of government-backed bonds. Service would restart in April under the proposal."

While the examples of this type of subsidization are ubiquitous, maybe, just maybe, economic sense is entering the picture.

Last month in Syracuse, Onondaga County lawmakers said they did not like the idea of a public subsidy worth at least $20 million for a 350-room hotel next to the county's convention center. That has delayed the deal as county officials and the developer look for ways to reduce the subsidy.

and

In October, Philadelphia Mayor John F. Sweet recommended rejecting developers' plans to redevelop a 13-acre riverfront site at Penn's Landing. Two finalists each proposed plans that needed a public investment of as much as $100 million, and Street called that "too much, given our priorities, and simply doesn't seem likely to happen," according to the Philadelphia Inquirer.

Do these successes mean we will see markets return to their role as allocator of capital and politicans look for ways to make sure investors have the money to invest (i.e. cutting taxes). I doubt it. Politicians have too much at stake to give up their pet projects so easily; projects all too often financed with our money.